Sovereign Debt Assessment

S&P Sovereign Rating: Fiscal consolidation, policy continuity and reforms brighten rating outlook • The ruling NDA got a weaker mandate in General Election 2024 compared to 2019 and 2014. However, a week before the election result was announced, rating agency S&P Global revised India’s sovereign rating outlook to ‘positive’ from ‘stable’, noting that regardless of the election result, it expected broad continuity in economic reforms and fiscal policies. While S&P retained India’s rating at BBB-, the outlook upgrade indicated that rating upgrade could follow in the next 24 months • In this series, we analyze global rating agencies’ criteria for sovereign rating and assess how India performs on the same. This report focuses on S&P’s Global’s sovereign rating criteria. Our analysis shows that: 1. The agency assesses sovereigns on five parameters viz. Institutional, Economic, External, Fiscal and Monetary. The first two form a country’s ‘Institutional and Economic Profile’ while the last three form its ‘Flexibility and Performance Profile’ o On ‘Institutional Assessment’, India scores 3, which as per the Agency’s definition indicates generally effective policymaking, evolving checks and balances and generally unbiased enforcement of contracts. On this pillar, India outperforms other BBB- rated countries o On ‘Economic Assessment’, India’s initial score is 5. This is mainly due to very low per capita income, indicating a narrow funding base that weakens creditworthiness. However, India’s faster trend growth compared to peer countries improves its initial score by one notch, taking the final score on this pillar to 4 o On ‘External Assessment’, India scores 1. S&P considers the INR to be an actively traded currency. Given India’s low external debt, on this pillar India far outperforms its peers and is on par with the likes of Germany, Singapore and Switzerland o The ‘Fiscal Assessment’ pillar is India’s Achilles Heel. High general government debt and high cost of debt servicing take India’s score to 6 on this pillar, significantly weaker than other BBB- rated countries and on par with defaulters like Lebanon and Sri Lanka. However, in the latest rating action S&P noted that may raise India’s rating if India's fiscal deficits narrow meaningfully such that the net change in general government debt falls below 7% of GDP on a structural basis. Along with fiscal consolidation, a negative interest rate-growth differential is likely to help India lower the debt burden. o On ‘Monetary Assessment’, India scores 3 outperforming BBB- rated countries. This indicates India’s ‘stabilized arrangement’ exchange rate regime, track record of central bank independence (albeit shorter), reliance on reserve requirements, and somewhat volatile REER Detailed report attached.

Is climate change priced into sovereign debt? Interesting BIS report released last week, confirming that higher physical climate risk is associated with higher yields (https://lnkd.in/eiecvPza) How do we measure exposure to physical climate risk? The ASR Sovereign Debt Scores combine 23 measures of climate risk across 65 sovereigns to asses this. While many may find a ranking too simplistic, we find it useful at identifying interesting outliers and surprising areas of climate exposure. The scatter plot below compares geophysical climate risk against resilience – the ability to adapt. Bottom right are poorly positioned: Pakistan, Egypt, Kenya and Tunisia are highest risk, but low debt ratings may already reflect this. India, Philippines and Mexico face higher downgrade risks. They are rated Baa2-3 and yet face relatively high physical climate risk. Saudi Arabia may appear exposed, based on the high ranking of physical risk, combined with relatively high Aa3 rating. However, in this case a strong macro balance sheet is helping – low levels of public debt, external debt and plentiful FX reserves could help act as a buffer to climate debt downgrade risks. This is where it becomes important to include an assessment of traditional fiscal and external macro vulnerabilities, alongside climate factors, in considering downgrade risks. Absolute Strategy Research Ltd

Developing countries in the Asia and Pacific region are at the forefront of climate change, and addressing urgent climate challenges requires substantial financial commitment. At the same time, the region is struggling under mounting debt burdens. The external sovereign debt of developing Asia and Pacific nations excluding the China has more than doubled since 2008. Rising debt burdens are becoming increasingly costly, with average debt servicing expenses over the past three years exceeding their pre-2020 levels by more than 40% as a share of government revenue. In a new study with Shamshad Akhtar and Alex Dryden, CFA, we analyse the region’s worsening debt dynamics and the additional strain posed by climate challenges, highlighting how unsustainable debt burdens threaten sovereign fiscal stability and undermine the ability of the developing Asia and Pacific region to meet its climate goals. It provides an overview of debt and development challenges in the region and discusses the risk it faces of an accelerating vicious circle of debt, climate change, and underdevelopment. And finally, it makes the case for concerted efforts to proactively tackle sovereign debt problems, which in some cases will require significant debt relief as a pathway to sustainable growth. You can download the paper here: https://lnkd.in/ek-bzCJE

I'm pleased to reveal the latest update to my sovereign debt stress tracker for 45 emerging and developing economies. This tool suggests that the countries most at risk of near-term sovereign debt strains are Argentina, Angola, and Pakistan, followed by Egypt, Nigeria, El Salvador, and Ukraine. Here's why. Though of course if you were already signed up to the free Sovereign Vibe newsletter you would have already received this information before anyone else. Disclaimer: looking at these macro variables doesn't account for the policy direction that countries are taking, so interpret these results with a grain of salt. This tracker plugs relevant data into an IMF logit model for market-access countries, released as part of the MAC Debt Sustainability Framework in 2021. Looking at the five countries most at risk of sovereign stress 1-2 years ahead: 1. ARGENTINA: Yet another sovereign default in 2023 - in local currency this time - has increased strains in Argentina, propelling it to the "top" spot. Another penalizing factor is Argentina's general government debt / GDP, which increased by a whopping 70 ppts from 2022 to 2023, rising from 85 to 155% of GDP. Check the IMF's 2024 WEO data if you don't believe me. 2. ANGOLA: Given the severe strains that Angola has been under lately, it seems the IMF is in the process of removing Angola from its list of MACs, so I will probably be doing so for the next update of the tracker. So I won't rub salt in the wound here. 3. PAKISTAN: Pakistan's public debt-to-revenue ratio is highest among this sample of 45 MACs, at eye-popping 674. 4. EGYPT: Egypt doesn't fare much better on debt-to-revenue, at 565, and saw general government debt/GDP rise by 7.4 ppts in 2023 and has a large, positive credit gap at > 4%. 5. NIGERIA: Nigeria scores worst-in-sample on institutional quality, while its general government debt/GDP rose by 6.8 ppts in 2023 and has a large debt-to-revenue ratio at 481. To never miss an update, be sure to get insights from the free Sovereign Vibe newsletter here: https://lnkd.in/dciG4RR9 --- Side note on defaults: Think of "stress history" as a lagged dependent variable. S&P counts 2023 defaults: -Foreign Currency: El Salvador, Cameroon, Ethiopia -Local Currency: Argentina, Ghana, El Salvador, Mozambique, Sri Lanka -The IMF does not consider Cameroon, Ethiopia, Ghana, and Mozambique to be MACs, so these countries are excluded from the list. A note on the visual below: this is percentile scoring within each column (i.e. variable), so the bright (dark) colors represent higher (lower) risks of sovereign debt stress.

 🌎 Excited to share our latest paper, “𝗦𝗼𝘃𝗲𝗿𝗲𝗶𝗴𝗻 𝗗𝗲𝗯𝘁 𝗖𝗼𝘀𝘁 𝗮𝗻𝗱 𝗘𝗰𝗼𝗻𝗼𝗺𝗶𝗰 𝗖𝗼𝗺𝗽𝗹𝗲𝘅𝗶𝘁𝘆,” coauthored with Jose Gomez-Gonzalez and Jorge M. Uribe, is now published in the 𝗝𝗼𝘂𝗿𝗻𝗮𝗹 𝗼𝗳 𝗜𝗻𝘁𝗲𝗿𝗻𝗮𝘁𝗶𝗼𝗻𝗮𝗹 𝗙𝗶𝗻𝗮𝗻𝗰𝗶𝗮𝗹 𝗠𝗮𝗿𝗸𝗲𝘁𝘀, 𝗜𝗻𝘀𝘁𝗶𝘁𝘂𝘁𝗶𝗼𝗻𝘀 & 𝗠𝗼𝗻𝗲𝘆. ⁣ ⁣ In today’s globalized economy, countries with more sophisticated production structures—those that manufacture high-value, complex goods—gain an advantage in international debt markets. But how much does economic complexity really influence sovereign borrowing costs?⁣ We explore whether a country’s economic complexity—its ability to produce specialized, non-substitutable goods—can significantly reduce its sovereign credit spreads (i.e., borrowing costs).⁣ ⁣ 📊 𝗞𝗲𝘆 𝘁𝗮𝗸𝗲𝗮𝘄𝗮𝘆𝘀:⁣ ⁣ ✔️ 𝗛𝗶𝗴𝗵𝗲𝗿 𝗲𝗰𝗼𝗻𝗼𝗺𝗶𝗰 𝗰𝗼𝗺𝗽𝗹𝗲𝘅𝗶𝘁𝘆 𝗹𝗲𝗮𝗱𝘀 𝘁𝗼 𝗹𝗼𝘄𝗲𝗿 𝘀𝗼𝘃𝗲𝗿𝗲𝗶𝗴𝗻 𝗯𝗼𝗿𝗿𝗼𝘄𝗶𝗻𝗴 𝗰𝗼𝘀𝘁𝘀, particularly for longer-term debt. Countries with more advanced production structures are perceived as less risky by investors.⁣ ⁣ ✔️ A one standard deviation increase in economic complexity can reduce 10-year sovereign spreads by up to 61 basis points—a substantial impact on financing costs.⁣ ⁣ ✔️ Economic complexity not only affects the level of spreads but 𝗮𝗹𝘀𝗼 𝘀𝗵𝗮𝗽𝗲𝘀 𝘁𝗵𝗲 𝘀𝗹𝗼𝗽𝗲 𝗼𝗳 𝘁𝗵𝗲 𝘆𝗶𝗲𝗹𝗱 𝗰𝘂𝗿𝘃𝗲, influencing a country’s ability to manage rollover risks at a lower cost.⁣ ⁣ ✔️ Traditional econometric models struggle to fully capture this relationship due to the number of confounding factors. To address this, 𝘄𝗲 𝘂𝘀𝗲 𝗰𝗮𝘂𝘀𝗮𝗹 𝗺𝗮𝗰𝗵𝗶𝗻𝗲 𝗹𝗲𝗮𝗿𝗻𝗶𝗻𝗴 𝘁𝗲𝗰𝗵𝗻𝗶𝗾𝘂𝗲𝘀 (DML and XGBoost), enabling a rigorous isolation of the impact of economic complexity.⁣ ⁣ ✔️ Beyond statistical significance, 𝗲𝗰𝗼𝗻𝗼𝗺𝗶𝗰 𝗰𝗼𝗺𝗽𝗹𝗲𝘅𝗶𝘁𝘆 𝗿𝗮𝗻𝗸𝘀 𝗮𝗺𝗼𝗻𝗴 𝘁𝗵𝗲 𝗺𝗼𝘀𝘁 𝗶𝗺𝗽𝗼𝗿𝘁𝗮𝗻𝘁 𝗱𝗲𝘁𝗲𝗿𝗺𝗶𝗻𝗮𝗻𝘁𝘀 𝗼𝗳 𝘀𝗼𝘃𝗲𝗿𝗲𝗶𝗴𝗻 𝗿𝗶𝘀𝗸—often surpassing traditional factors like GDP growth and debt-to-GDP ratios.⁣ ⁣ 🎯 W𝗵𝘆 𝗱𝗼𝗲𝘀 𝘁𝗵𝗶𝘀 𝗺𝗮𝘁𝘁𝗲𝗿?⁣ ⁣ For policymakers, these findings highlight that fostering economic complexity isn’t just about growth—it’s about financial resilience. Countries with more complex economies benefit from cheaper, more stable access to international capital, improving fiscal sustainability, and reducing financing risks.⁣ ⁣ 📄 Read the full paper here: https://lnkd.in/ehH6Uv8f Ana María Ibáñez, Emilio Pineda, Axel Radics, Marta Ruiz Arranz,Jorge M. Uribe, Jose Gomez-Gonzalez ⁣ #EconomicComplexity #CreditRisk #YieldCurve #SovereignRisk